New Delhi/ Bangalore: The government clarified Thursday that software developed overseas at a client’s site will be eligible for tax benefits as it will be classified as exports, in a move that should bring cheer to Indian technology companies and reduce tax litigation.
The income tax (I-T) department also clarified that profit earned from the deployment of manpower at a client’s overseas site for software development won’t be denied tax benefits under Sections 10A, 10AA and 10B of the Income Tax Act, subject to certain conditions.
The tax department and information technology (IT) firms have been sparring over these issues for several years and the clarifications should bring cheer to an industry that has already been buoyed by unexpectedly strong results for the three months ended December from three of its top five companies—Infosys Ltd, HCL Technologies Ltd and Tata Consultancy Services Ltd.
“We are very pleased the ministry of finance has taken the necessary steps to deal with the tax disputes the industry has been facing over the years,” Wipro Ltd chief financial officer Suresh Senapaty said in an email response. “This will put to rest many issues which have been under litigation. We hope the department will take the follow through steps to withdraw the demands/appeals that are pending in this respect.”
Section 10A of the Income Tax Act provides for a five-year tax holiday for companies that manufacture or produce anything in software technology parks. Section 10B of the Act allows for a five-year tax holiday for approved 100% export-oriented undertakings (EOUs) that manufacture or produce any article. Both tax holidays ended in March 2011 and IT companies have been lobbying for their reinstatement.
The I-T department’s clarifications follow the recommendations of the N. Rangachary committee constituted by the Prime Minister last year to study the issue.
The clarifications should reduce the quantum of disputes between IT firms and the I-T department, said Poonam Kishore Saxena, chairman, Central Board of Direct Taxes (CBDT). The I-T department refused to give an estimate of the amount involved in such disputes.
For instance, Infosys was slapped with a tax demand of more than Rs.450 crore for claiming exemption on profits earned from its onsite work that it had declared as exports. Wipro and iGate Corp. also received tax scrutiny notices on similar grounds.
Infosys welcomed the move.
“We are delighted by the clarifications issued by CBDT,” said V. Balakrishnan, member of the board and head, BPO, Finacle and India business. “It removes one big uncertainty for the industry and will help the industry focus on growth in this challenging business environment. We are grateful to the chairman and members of the Rangachary committee for understanding and being sympathetic to the industry’s viewpoints.”
The industry lobby also broadly welcomed the move but said implementation of the rules will play a vital role.
Nasscom said it hopes “the assessments and past denials are suitably resolved, taking into cognizance the clarifications issued. While this is a positive step, it is important that the implementation is carried on efficiently”.
It also urged that benefits denied in the past should be reviewed in light of these clarifications and sought swift closure of cases.
A senior executive said on condition of anonymity, “Indian IT industry has tax disputes worth hundreds of millions of dollars accumulated over past four-five years. Of this, service tax-related disputes would be at least Rs.4,100 crore.”
Saxena said the clarifications are a part of the government’s efforts to provide a non-adversarial and stable tax regime as promised by finance minister P. Chidambaram when he took charge in August last year.
She added that the government is still examining the Rangachary panel’s recommendations on safe-harbour regulations and development centres.
Saxena also clarified that the Rangachary panel had not made any recommendations on the retrospective taxation of payments made towards imported packaged software that was announced in last year’s budget. The recommendations of the panel haven’t been made public.
The I-T department said in its release that software developed abroad at a client location would be eligible for benefits, provided there exists a “direct and intimate nexus or connection of development of software done abroad with the eligible units set up in India”.
The benefit to profits earned as a result of the deployment of technical manpower for software development work will also be eligible for tax benefits, provided these people are working on the development of such software.
This wasn’t clear until now and iGate Corp., for instance, was asked to pay tax of Rs.11 crore by the I-T department for onsite software development and work that involves deputation of technical manpower. The company disputed the claim and chief executive officer Phaneesh Murthy, who welcomed the tax department’s Thursday announcement, claimed it had already won its case at the I-T commissioner level.
The I-T department also clarified that tax benefits will not be denied merely on the ground that a separate master service agreement does not exist for each work contract. It said a separate book of accounts need not be maintained for the eligible units.
And it added that engineering and design will be considered as research and development for purpose of claiming tax benefits.
Units will also be eligible for tax benefits in case of physical relocation from one special economic zone to another, the department said.
It added that whether or not such benefits will be available after the sale of a business will be determined by the nature and timing of such a transaction.